Economics Tuition Singapore A Level H2 H1 Economics Tuition – Fears are growing that the UK

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Economics Tuition Singapore A Level H2 H1 Economics Tuition – Fears are growing that the UK

Introduction:

• Define stagflation: A period of persistent rise in GPL coupled with high unemployment and stagnating or falling real national income.
• Direction of essay: This essay aims to explain the factors causing a simultaneous change of rising AD and falling AS leading to rising GPL and falling employment as well as falling real national income.

Body:

One possible factor of stagflation is falling AD. 

UK’s trading partners such as USA may be experiencing economic recession which means there is falling national incomes in USA. This will lead to a fall in purchasing power of their residents which leads to fall in demand for their own domestically produced goods and services as well as foreign produced goods and services such as those from UK. UK will experience a fall in demand for her exports. This leads to a fall in total revenue of her exports. Assuming total expenditure on imports constant, there is a fall in (X-M). Thus, there leads to a fall in aggregate demand. This is represented by a leftward shift of AD curve from AD₀ to AD₁.

Another factor that could lead to stagflation is rising oil prices which resulted in falling SRAS. 

E/E2: Oil is an important input to produce many final goods and services. Oil is traded internationally and is subjected to market conditions as well as production decision by the major oil producing countries, Organization of the Petroleum Exporting Countries (OPEC). Increase in price of oil could be due to OPEC restricting its output so as to raise price to gain higher revenue. Thus, leading to fall in supply of oil and hence, a rise in price of oil. When UK imports oil from these countries, she experiences a rise in costs and hence a fall in profits. UK firms will reduce their supply of final goods and services. There will be a fall in SRAS represented by a leftward shift of SRAS curve from SRAS₀ to SRAS₁.

Stagflation arises due to fall in AD and a larger fall in AS occurring simultaneously resulting in higher GPL. 

When both AD and AS fall simultaneously, assuming the fall in AS is greater with oil prices taking up a huge proportion of total cost in many industries, there will be a shortage Y₂Y₃ at original GPL which exerts upward pressure on GPL. As GPL rises, level of AS rises and level of AD falls, ceteris paribus. GPL continues to rise until the shortage is eliminated. Thus, resulting in persistent rise in general price level of goods and services from P₀ to P₁ and falling real national income from Y₀ to Y₁. Since there is a fall in production activities due to a relatively larger fall in SRAS compared to fall in AD, there is a fall in employment of resources such as labour because labour is a derived demand. This leads to rising unemployment as well.

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